As the US Treasury yields soared to their highest in two years yesterday, foreign investors sold off bond and equity, pushing rupee to an all-time low of Rs62/$
The Sensex today fell by a huge 769 points, a selloff that has no apparent reason except that the rupee weakened a bit more. Rupee has been weak for the past two months and today it weakened by 0.77% to 61.99. What caused this massive selloff, when Rupee had already closed at Rs61.54 on August 6th?
One of the most important reasons lies in little-discussed US bond market. Yesterday, August 15th, the 10-year US Treasury yield touched 2.823%, its highest level since August 2011. The US Labour department on the day reported that the total number of Americans filing for unemployment benefits for the first time last week fell to a near six-year low. A week back we had mentioned to keep an eye on US Treasury yields (Read: Rupee Weakness: Its not just CAD, keep an eye on US 10-year yield). US Yields are rising because of fears that the Federal Reserve may start tapering its bond-buying programme of $85 billion a month. As US economic data continues to improve, this has led to a sell-off in the US treasury market, on expectations that the Fed will pull back its monetary stimulus program. What does this have to do with Indian market?
In the Indian market, over the past five trading days, foreign institutional investors (FIIs) have sold over Rs6,500 crore of bonds in the debt market. The 10-year Indian Government bond yield was up by 36 basis points from 8.14% as on 8th August to close at 8.50% on 14th August.
The Indian economy has become too dependent on foreign capital. In the past few months we have seen a heavy outflow from the debt markets because of rising US yields, weakening the rupee. The central banks efforts to tighten liquidity in order to boost the rupee have turned out to be fruitless in the face of such huge outflows. In the past two and a half months there has been an outflow of over Rs50,000 crore of foreign investments from the Indian debt market. As seen in 2007-08, the rupee appreciation happened mainly due to FII inflows into the capital market in India.
What next? US Treasury bond yields are near their lowest levels in the last two decades. With the recent uptrend in yields and with signs that the Fed may end its stimulus programme, will yields continue to trend higher? Rising US yields would make emerging market bonds look even more unattractive leading to massive sell-off from bond markets of these countries, leading to a further weakening of rupee. That is the worry for FIIs, making them sell.
Unlike equity markets, where investors look for the long term rise in value thanks to rising corporate profits, in debt markets a few basis points difference could inflict losses with little chance that holding the bonds for the long term would turn a loss into a profit.
Also, given India’s current economic situation with a high current account deficit, rising inflation and depreciating rupee it would be highly unlikely for the Reserve Bank to cut interest rates soon and bond yields would fall. FIIs have a total investment of $28,700 million as on 14 August in the Indian debt market. This has come down from around $37,400 million as on the end of May 2013. There is still a huge amount of assets of FIIs in the debt market and this leads fears if they continue to sell their investments. This has caused fear and panic in the minds of investors, especially the FIIs and this is one of the reasons there has been a massive sell-off in the equity market as we have seen today.
The inefficiency of the UPA-2 government does not give any hope. Exports are weak, foreign investment has slowed down and India is mainly dependent on FII capital inflows for equity and debt. There is no immediate solution to India’s fundamental problems of a wide current account deficit and funding this deficit in an uncertain global economy through capital account. As long as US bond yields keep rising on better US economic data, we may see further outflows from the Indian debt market which would lead to a weaker rupee and weaker stock prices, under the current correlation. Conversely, a weakening of US bond yields will set up a corrective rally.
Nifty crashed through 5,635 and headed sharply lower. More decline may be in store
As the Dow Jones Industrial Average crashed yesterday by 226 points and US 10-year treasury yield crossed 2.8%, a 2-year high, the Reserve Bank of India (RBI) measures to control the rupee fall by imposing selective capital controls on outward remittances, failed hopelessly. In the face of such global headwinds, a massive selloff hit the Indian market on Friday. The Sensex and Nifty both opened in the negative and soon they hit their respective intra-day high. After this, both the indices slid continuously and closed deeply in the negative.
The Sensex opened lower at 19,297 and hit a low of 18,560 and closed at 18,598 (down 769 points or 3.97%). Nifty opened lower at 5,705 and hit a low of 5,496 and closed at 5,508 (down 234 points or 4.08%). The percentage loss of 3.97% on the Sensex is the maximum since 22 September 2011 while for the Nifty, the loss has been the maximum since 17 August 2009. The National Stock Exchange (NSE) recorded a volume of 68.12 crore shares.
All the major indices on the NSE except for India Vix (up 26.42%) and Nifty Dividend which ended flat, closed in the negative. Lix 15 was the top loser, down 5.65%.
All the other indices ended in the negative. Realty (down 6.66%); Bank Nifty (down 5.74%); Metal (down 5.47%); PSU Bank (down 5.38%) and Finance (down 5.27%) were the top five losers.
Of the 50 stocks on the Nifty, three ended in the in the green. The top gainers were Hero MotoCorp (up 2.17%); Power Grid (up 1.13%) and HCL Technologies (up 0.20%) while Jaiprakash Associates (down 11.09%); BHEL (down 10.92%); Axis Bank (down 9.36%); Bank of Baroda (down 8.63%) and Reliance Infrastructure (down 8.52%) were among top losers today.
The RBI on Wednesday increased efforts to stem the rupee’s plunge by cutting the amount local companies can invest overseas without seeking approval to 100% of their net worth, from 400%. Among other measures, the RBI has also announced reduction in the limit for remittances made by resident individuals, under the Liberalised Remittance Scheme (LRS Scheme), to $75,000 from $200,000 per financial year. The present set of measures is aimed at moderating outflows. However, any genuine requirement beyond these limits will continue to be considered by RBI under the approval route.
Also on Wednesday, the banking regulator banned import of gold coins and medallions. Now importers of gold will have to pay upfront before getting any of the yellow metal with the condition that at least 20% of the gold imported will have to be re-exported and the balance for domestic use.
US market fell sharply on Thursday. The better-than-expected data of jobless numbers heightened fears of imminent tapering of the Federal Reserve's bond-buying program. Market now awaits the reports on US housing starts and consumer confidence.
Except for Taiwan Weighted (up 0.48%), all the other Asian indices fell. Jakarta Composite fell the most, 2.49%. Indonesia is in the same situation as India – of rising interest rates and inflation.
China’s stocks had a torrid day today ending in a negative territory apparently due to a computer glitch. The Shanghai Stock Exchange (SSE) said this afternoon that the department of investment strategy of Everbright Securities Company encountered a problem in its arbitrage system when it was operating on its own funds during the morning trade on the bourse.
So far, there is no official conclusion as to whether there is a direct correlation between Everbright’s trading error and the market’s sudden surge, state-run Xinhua news agency reported.
European indices were trading mostly in the red while US Futures were trading in the positive.
TVS Motor Company has dis-invested 7.35 crore shares of its unit TVS Energy Ltd, constituting 90.46% of share capital of TVS Energy to Green Infra Ltd. Consequently, TVS Energy and its subsidiaries, viz., TVS Wind Power Ltd and TVS Wind Energy Ltd, cease to be subsidiaries of the TVS Motor from 16th August. TVS Motor fell 4.67% to close at Rs30.60 on the NSE.
Even though Finance Ministry and IRDA are gung-ho about banks getting insurance broking license to help penetration of insurance products, it is the RBI which will decide whether banks will continue as corporate agents or become brokers and sell any insurance product
Finance Secretary Rajiv Takru on Wednesday gave a candid speech at 16th CII Insurance Summit in Mumbai. According to him, “Certain sections (insurers) may not be keen on banks getting insurance broking license as it will hurt existing relations. But, to be fair and also to give the customer choice, banks with broking license should be the way forward.” The finance ministry has been in favour of banks becoming insurance brokers. In his budget speech this year, Finance Minister P Chidambaram said banks would be so permitted to help insurance penetration. But will RBI oblige, especially since RBI’s deputy governor Dr KC Chakrabarty is personally against banks selling any kind of insurance?
Currently, a bank is allowed to sell the products of only one life and non-life insurance company as a corporate agent. Speaking on the sidelines of 16th CII Insurance Summit, Insurance Regulatory and Development Authority (IRDA) Chairman TS Vijayan, said, “There have been informal discussions with RBI. People have reservations with the word ‘broker’. Broker regulations are more in tune with larger risks like reinsurance. But, we are not expecting banks to sell huge risk. It is a personal line of business for them. This idea will get acceptance widely, among both companies and banks. Today, a bank is the corporate agent of one insurance company (Life and General). While an agent represents the company, a broker represents the customer. As such, banks utilise own customer base and hence represent the customer. With broking license, they can give the best deal and product to the customer.”
According to a senior IRDA official, “RBI is not keen on banks becoming brokers as many of them have promoted insurance companies and this could lead to a conflict of interest. With broking license, banks will have a fiduciary responsibility to customers and can be made accountable for mis-selling.” RBI holds all the aces, which at present, points to status-quo of bank continuing as corporate agents.
Even if RBI were to relent and allow banks to go for insurance broking license, how many banks that promote own insurance company will really apply for it? In an interview with Business Standard, Canara HSBC OBC Life Insurance CEO John Holden, said, “For us, bancassurance is not a channel, it’s a business model. We have always been a proud 100 per cent bancassurer. That strategy and business model are working.” Top private insurance companies are backed by banks which will find conflict of interest about being open to the broking idea. For example, ICICI Pru Life, SBI Life, HDFC Life, IDBI Federal, SUD Life, Kotak Life and IndiaFirst are backed by banks like ICICI, HDFC, SBI, IDBI, Federal bank, Bank of India, Union bank of India, Kotak Mahindra, Bank of Baroda and Andhra Bank.
IRDA Chairman is optimistic about broking model. Mr Vijayan, says, “An insurance company promoted by a good bank is in a comfort zone. It is limited to monopoly situation of one insurance company product sale. But, even bank promoted insurance company has opportunity (if banks opt for broking license) to sell their products through other banks currently not sold through. Today, the insurer may have bank as captive distributor, but with broking license they will have to go out and sell products suitable to the customer.” Time will tell if a bank that promotes an insurance company bites the bait of broking license.
According to Shashwat Sharma, partner, KPMG India, “Many banks who have promoted their own insurance company and have signed distribution agreements for promotion of products of their own insurance JV (joint venture) may find it difficult to immediately become a broker as it may impact their proposed breakeven plan and shareholder returns. Also, those banks whose JVs would manage to reduce their dependence on the partner bank through growth of other distribution channels are more likely to become brokers.”
RBI's financial stability report’s Chapter III - Financial Sector Regulation and Infrastructure raises several crucial questions on bancassurance model’s use of unfair and restrictive practices.
While banks are well suited to distribute insurance products because of their wide network, several issues have risen regarding their conduct in the process, pertaining to mis-selling and certain restrictive/ unfair practices (such as linking provision of locker facilities to purchase of insurance products, selling of unsuitable and/or multiple policies etc).
According to IRDA’s Annual Report 2011-12, the maximum complaints in life insurance related to mis-selling, mainly pertaining to private sector, although state-owned LIC leads the business with over 70% share. Complaints were mainly in the nature of unfair trade practices and mis-selling of products (e.g. malpractices, actual product sold being different from what was proposed, single premium policy being issued as annual premium policy, surrender value being different from projected, free look refund not paid, misappropriation of premiums).
As a significant portion of private life insurance companies use banks as their corporate agents, there seems to be an urgent need to revisit the marketing and sales strategies used by the banks in pushing insurance products, especially since insurance is among the more complex financial products for common man to comprehend.
Given that this is the current thinking of the RBI, it will be a surprise if the banks are allowed to act as brokers.